United States: NAFTA 2.0 - Investment Protection And Dispute Settlement Under Chapter 14 Of The United States-Mexico-Canada Agreement

After more than a year of sometimes contentious negotiations,
the United States, Mexico, and Canada reached an agreement on
September 30 to revise the North American Free Trade Agreement
(NAFTA)—renaming it the United States-Mexico-Canada Agreement
(USMCA). Although the substantive protections for foreign
investment in Chapter 14 of the USMCA largely track those in
Chapter 11 of the NAFTA, the scope of investor-State dispute
settlement is drastically reduced. These changes appear to reflect
the Trump Administration's broader skepticism of international
dispute resolution mechanisms. Moreover, in a significant departure
from the NAFTA, Canada has not signed on to the investment
arbitration mechanism. This means that U.S. and Mexican investors
cannot bring claims against Canada under the USMCA, nor can
Canadian investors bring such claims against Mexico or the United
States.

Changes to Investment Protections

There are three changes of potential importance to the
substantive investment protections in Chapter 14 of the USMCA, as
compared to Chapter 11 of the NAFTA: (i) the definition of
investment in Article 14.1; (ii) the definition of claimant under
Article 1 of Annex 14-D; and (iii) the provision on the minimum
standard of treatment for investments in Article 14.6.

Under Article 1139 of the NAFTA, "investment" is
defined by a closed list of examples that include "an
enterprise," "real estate or other property, tangible or
intangible," and certain kinds of contracts. In contrast,
Article 14.1 of the USMCA—like other recent U.S. free trade
agreements—defines investment in a manner more typical of
investment treaties, as "every asset that an investor owns or
controls, directly or indirectly, that has the characteristics of
an investment, including such characteristics as the commitment of
capital or other resources, the expectation of gain or profit, or
the assumption of risk." This more general definition is then
followed by an open list of examples, with an express exclusion
only for "an order or judgment entered in a judicial or
administrative action" and "claims to money that arise
solely from commercial contracts for the sale of goods or
services" and related extensions of credit. It remains to be
seen whether this potentially more expansive definition of
investment will be interpreted in a materially different way than
Article 1139 of the NAFTA.

Under Article 1 of Annex 14-D of the USMCA, "claimant"
is defined as "an investor of an Annex Party [i.e., the United
States or Mexico], excluding an investor that is owned or
controlled by a person of a non-Annex Party that the other Annex
Party considers to be a non-market economy, that is a party to a
qualifying investment dispute." This restriction on U.S. or
Mexican claimants owned or controlled by a national or enterprise
of a non-market economy is new compared to the NAFTA and appears to
be directed at Chinese-owned or -controlled investments in the
United States and Mexico. While both the NAFTA (in Article 1113)
and the USMCA (in Article 14.14) already contain denial of benefits
clauses, those clauses only allow a respondent State to deny the
benefits of the investment chapter—including access to
investor-State arbitration—to an enterprise of another Party
that is owned or controlled by third-State nationals and that has
no substantial business activities in the territory of the Party in
which it is incorporated. The new exclusion for U.S. or Mexican
claimants owned or controlled by a national or enterprise of a
non-market economy is broader because it excludes a would-be
claimant from arbitration even where the U.S. or Mexican company
engages in substantial business activities in its State of
incorporation.

Finally, Article 14.6 of the USMCA requires the Contracting
Parties to "accord to covered investments treatment in
accordance with customary international law, including fair and
equitable treatment and full protection and security." This
language is almost identical to that found in Article 1105(1) of
the NAFTA. The USMCA, however, also incorporates the clarification
in the NAFTA Free Trade Commission's July 31, 2001, statement
to the effect that the treatment required is limited to the
customary international law minimum standard of treatment. Article
14.6 of the USMCA goes further than the FTC's statement by
providing that "the mere fact that a Party takes or fails to
take an action that may be inconsistent with an investor's
expectations does not constitute a breach of this Article, even if
there is loss or damage to the covered investment as a
result." This new provision, at Article 14.6.4, appears
directed at recent NAFTA awards relying on the respondent
State's frustration of an investor's legitimate
expectations about the stability of the regulatory environment in
finding a violation of the minimum standard of treatment in Article
1105(1). The language in Article 14.6.4 codifies the litigation
position of the NAFTA Parties in responding to these claims and may
further constrain tribunals' interpretation of the scope of the
minimum standard of treatment.

Changes in Dispute Settlement

Turning to dispute settlement, the most significant changes to
Chapter 14 of the USMCA in comparison to the NAFTA relate to the
investment arbitration mechanism as laid out in Annexes 14-C, -D,
and -E. Perhaps the biggest change, noted above, is that Canada has
not signed on to Annexes 14-D and -E. As a result, other than for
Legacy Claims under Annex 14-C (discussed below), U.S. and Mexican
investors cannot bring arbitration claims against Canada under the
USMCA, nor can Canadian investors bring such claims against the
United States or Mexico. (Canadian investors in Mexico and Mexican
investors in Canada will, however, have access to investment
arbitration under the Comprehensive and Progressive Agreement for
Trans-Pacific Partnership once it enters into force.) There are
also numerous changes to the investment arbitration regime for
claims against Mexico (by U.S. investors) or the United States (by
Mexican investors).

The Annexes to Chapter 14 of the USMCA create three categories
of claims:

Legacy Claims.
Investment arbitrations that are ongoing under the NAFTA may
continue (Annex 14-C, paragraph 5). In addition, investors that
have made investments covered by the NAFTA before it is terminated
have three years from the date of termination of the NAFTA in which
they can bring a claim under the provisions of the NAFTA (Annex
14-C, paragraphs 1, 3, and 4). This is important because investment
arbitration under the USMCA is significantly more limited than
under the NAFTA, as discussed below. Those U.S. or Mexican
investors that are eligible to submit claims under Annex 14-E,
however, must use that mechanism even if they would otherwise
qualify for arbitration under the NAFTA (Annex 14-C, footnote
21).

Mexico-United States
Investment Disputes. The majority of claims under the
USMCA will likely arise under Annex 14-D. The arbitration mechanism
in Annex 14-D is similar to that in Section B of NAFTA Chapter 11,
but there are some key differences. First, the substantive basis
for investment claims under Annex 14-D of the USMCA is limited.
Most importantly, an investor cannot bring a claim for breach of
the minimum standard of treatment in Article 14.6 or for indirect
expropriation under Article 14.8 (Annex 14-D, Article 3). Given
that these have been the two most-often used bases for claims under
the NAFTA, their exclusion from the arbitration mechanism under
Annex 14-D makes the protections under the USMCA of significantly
less value to investors than the protections that are currently
available under the NAFTA. Claimants under Annex 14-D can only
bring claims for certain kinds of national treatment and
most-favored-nation treatment (MFN) violations and for direct
expropriations (Annex 14-D, Article 3). National treatment and MFN
claims related to the establishment or acquisition of an investment
are also excluded; a claimant is therefore limited to claims
alleging discrimination with respect to the "expansion,
management, conduct, operation, and sale or other disposition of
investments" (Articles 14.4 and 14.5). Moreover, a claimant
may not use the MFN clause to seek to incorporate more favorable
substantive protections from other investment treaties to which the
United States or Mexico is a party (Annex 14-D, footnote
22).1

Second, in contrast to the NAFTA (and most other investment
treaties), the USMCA requires that a would-be claimant first
litigate the challenged measure "before a competent court or
administrative tribunal of the respondent" (Annex 14-D,
Article 5). The claimant must litigate until it receives a
"final decision from a court of last resort" or 30 months
have passed from the date the local court proceedings were
initiated. This time counts against the four-year statute of
limitations for claims under Annex 14-D. Moreover, if U.S.
investors in Mexico allege a breach of the USMCA itself (as opposed
to a breach of Mexican law) in the local court proceedings, this
will bar any subsequent investment arbitration (Annex 14-D,
Appendix 3). There is an exception to this local litigation
requirement "to the extent recourse to domestic remedies was
obviously futile or manifestly ineffective" (Annex 14-D,
footnote 24).

Third, there are some procedural innovations in the USMCA compared
to the NAFTA. For example, if the disputing parties fail to agree
on a place of arbitration, the tribunal may choose a place of
arbitration in any State party to the New York Convention (Annex
14-D, Article 7.1). The NAFTA, in contrast, limits the tribunal to
a place of arbitration within the NAFTA States (Article 1130). This
change may be due to the fact that the limitation of investment
arbitration to two States, rather than three, means that there is
no "neutral" third State party to the treaty in which an
arbitration can be seated. The USMCA also establishes a mechanism
for the expedited consideration of jurisdictional objections and
objections that a claim is manifestly without legal merit (Annex
14-D, Articles 7.4 and 7.5), along the lines of the mechanism in
Article 10.20 of the CAFTA-DR. Unusually, the USMCA provides the
disputing parties a right to review and comment on a draft of the
award before it is issued (Annex 14-D, Article 7.12).

In addition to transparency provisions ensuring the publication of
arbitration-related documents and access to hearings (Annex 14-D,
Article 8) and permitting amicus participation (Annex 14-D, Article
7.3), the USMCA also imposes certain ethical obligations on
arbitrators (Annex 14-D, Article 6.5). Specifically, arbitrators
must comply with the International Bar Association Guidelines on
Conflicts of Interest in International Arbitration and refrain from
taking instructions from any organization or government regarding
the dispute. The USMCA also prevents "double-hatting" by
requiring arbitrators to "refrain, for the duration of the
proceedings, from acting as counsel or as party-appointed expert or
witness in any pending arbitration under the annexes to this
Chapter." These obligations can be seen as a response to
criticisms that arbitrators in investment disputes currently lack
sufficient independence.

Mexico-United States
Investment Disputes Related to Covered Government
Contracts. In contrast to the limited set of claims
available under Annex 14-D, Annex 14-E allows investment
arbitration for alleged breaches of any of the substantive
protections in Chapter 14 (including indirect expropriation and
violation of the minimum standard of treatment) for disputes
related to covered government contracts. Annex 14-E does not
include the pre-arbitration local litigation requirement that
applies to U.S. and Mexican claimants under Annex 14-D.

Covered government contracts are limited to written agreements
between an investor or investment and a "national
authority" of the respondent State related to certain sectors,
which the investor relied on in making its investment. The covered
sectors are oil and gas, power generation, telecommunications,
transportation, and ownership or management of infrastructure. This
provision appears intended to provide additional protections to
U.S. investors, especially in the oil and gas sector, that have
entered into contracts with Mexican national authorities.

Certain caveats apply even to arbitration under Annex 14-E.
Claimants must wait at least six months from the events giving rise
to the claim before initiating arbitration (Annex 14-E, paragraph
4). There is also a three-year statute of limitations for claims
(Annex 14-E, paragraph 4). The respondent State must be a party to
at least one other "international trade or investment
agreement that permits investors to initiate dispute settlement
procedures to resolve an investment dispute with a government"
(Annex 14-E, paragraph 2(a)(i)(B)). And the United States and
Mexico expressly retain the right to "modify or eliminate this
Annex" (Annex 14-E, paragraph 5).

Conclusion

The investment arbitration provisions in the USMCA represent a
significant departure from the NAFTA. U.S. and Mexican investors in
Canada cannot bring claims against Canada under the USMCA, nor can
Canadian investors bring such claims against the United States or
Mexico. U.S. and Mexican claimants will have fewer potential bases
for a claim (except where they are relying on a government contract
in a covered sector) and will have to undertake potentially onerous
domestic litigation before initiating arbitration.

The USMCA still has to clear major hurdles, as the United
States, Canada, and Mexico must each ratify the agreement in their
domestic legal systems before it can enter into force. In the
United States, that will require Congress to pass implementing
legislation. The timing of a Congressional vote is uncertain as of
this writing. Nevertheless, in light of these possible changes,
investors with potential claims may choose to consider initiating a
claim under the NAFTA while it is still in force or during the
three-year sunset period under the USMCA, rather than waiting until
a later time when they may be limited to bringing claims under
Annex 14-D of the USMCA. More generally, going forward, U.S.
investors may have to consider other potential means of protecting
their investments in Canada and Mexico beyond investment
arbitration under the USMCA.

Footnote

1. A U.S. or Mexican investor can also use this mechanism
to bring an investment arbitration claim under Chapter 17 on
Financial Services, subject to similar limitations on the type of
claims available (Chapter 17, Annex 17-C, paragraph 2). There are,
however, some differences in the procedures that a would-be
claimant must follow.

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